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Jasper Lawler

European markets fell on Friday after the Spanish socialist party (PSOE) leader, Pedro Sanchez, declared his intention to organize a no confidence vote to topple the current government over the ongoing Gürtel political corruption scandal.

With increasing concerns over a new political crisis in the Euro Zone, investors on Friday fled from risky European assets:

The IBEX — the Spanish benchmark — suffered its biggest fall since February, losing as much as 2.7%,

The Euro reached its lowest level in 6 months,

Spanish 10-year bond yields surged as high as 13 basis point (bp) to 1.52%,

Meanwhile, German bonds, commonly considered to be a financial safe haven, have had their biggest gain since July 2012, with yields down as much as 19 bp to 0.39%.

The reason behind this sell-off is mainly political. Not only could the populist revolt in Spain lead to a snap election, but the situation in Italy is equally unstable, as the newly-appointed Prime Minister Giuseppe Conte has already resigned from his position.

These recent developments raise questions about whether this is “politics as normal”, or if they signify a more fundamental shift that traders should be wary of.

Why does the Spanish opposition want to oust the current government?

Political corruption scandals and protests have engulfed the Popular Party (PP), since Mariano Rajoy took office in 2011 as Spanish Prime Minister. This ongoing political corruption scandal, called the Gürtel case, accused Spain’s major right-wing party of bribery, tax evasion and money laundering between 1999 and 2005.

Last Thursday, the Spanish High Court (the “Audiencia Nacional”) sentenced 29 people linked to Rajoy’s political party to jail for the use of illegal slush funds — such as Francisco Correa, considered as the leader of this corruption system, Pablo Crespo, former secretary of Galicia, and Luis Bárcenas, former treasurer.

While Rajoy testified in court last July denying being aware of such a secret accounting system, called caja b, allowing misappropriation of funds, many are now wondering how truthful the Prime Minister’s statement was.

On Friday, Spain’s biggest opposition party, the PSOE, filed a motion to oust Rajoy’s government after the PP was declared guilty, and wants to call for snap elections to form its own socialist government – and with 176 votes in Congress, it can succeed. The Prime Minister would then be overthrown, one year from regional, municipal and European elections and two years from legislative elections. The Podemos party backs up the PSOE, and the Ciudadanos party said that he could work with the opposition if they support an alternative candidate that is not Sanchez, nor Albert Rivera (Ciudadanos’ leader).Rajoy said on Friday that he refuses to hold early elections, as he intends to remain in office until the end of his term, which is in mid-2020.

The Prime Minister has survived many criticisms since he took office, but he doesn’t have much recourse to defend his party, as this no confidence vote is severely weakening the PP. So, how well will he do this time?

What to expect now?

This severe political crisis could very well lead to the fall of the current government, having lost much of its credibility. However, the vote isn’t sure to go ahead, as the socialists need the backing of many other parties to be able to proceed with the no confidence vote.

Increasing political instability from both Italy and Spain is affecting market sentiment about the Euro Zone’s stability and growth outlook. However, there are different degrees of risk regarding the Spanish situation compared to Italy’s. For instance, economical and fiscal improvements have been made in Spain, and its financial situation is more stable than Italy’s – not to mention that the potential new Eurosceptic Italian government will likely not be ready to work hand-in-hand with Brussels.

The growing erosion of investor confidence will likely increase market volatility in the upcoming weeks, on all European asset classes.

Even though the Euro bounced back following the rejection of the Eurosceptic Italian finance minister candidate, it will likely remain under pressure, and could easily fall further as long as the situation remains unstable in Spain and Italy. Regarding the IBEX index, investors might be overreacting but traders must be careful as the index remains volatile and could react unpredictably to any new developments.

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